The Meaning of CPI Bias

Dean Baker and Jared Bernstein:

Dean Baker argues that new good bias in the Consumer Price Index has only a small effect on our estimates of the lifestyles of the poor and working--as opposed to the lifestyles of the rich and famous, where it has a bigger impact:

Beat the Press: Middle Class Living Standards: Changing the Yardstick: The story on middle class living standards over the last quarter century is pretty bleak.... [M]any of those arguing that living standards actually have been increasing rapidly go behind the data and argue that the consumer price index (CPI) overstates the true rate of inflation.... David Leonhardt presents this case today based on the anecdotes of Robert Gordon, a member of the notorious Boskin Commission, and one of the leading proponents of this view. As the Boskin Commission's primary opponent, I can't let this one slide.

This issue raised in the column is the question of "new goods bias," the idea is that some goods enter the market initially at very high prices, but then the price drops rapidly in their first years on the market. The bias results from the fact that the consumer price index (CPI) does not include the new product until after its period of rapid price decline, therefore missing large prices declines that would lower the average rate of inflation. This would have been more of a problem in prior decades....

I always thought that the claims about the size of new goods bias were probably overstated, but insofar as it exists, it is primarily something that leads to an overstatement of the CPI for rich people. The example of the snow blower that Leonhardt highlights in his column is probably a good one to illustrate the basic issue.... The key question is how many people bought snow blowers in the fifties when they were clumsy and expensive? Probably not many, and those who did were mostly rich people who could afford expensive toys. Most of the drop in snow blowers' prices took place before the middle class began to buy them. This drop provided a gain to those who already were buying snow blowers, but it provided zero gain to those who found them too expensive to be worth their money....

During the Boskin controversy people often cited the example of the cell phone, which managed to slip through the cracks until the mid-nineties (97, if I remember right).... I once debated an economist... asked him how much this oversight led to an overstatement in the cost of living for the half of the population that still didn't own a cell phone.... [R]emembering economic theory, he gave the correct answer "zero."

Of course, the cell phone was an extreme case... but in general the story of new goods with big price declines not being picked up in the CPI was a story that affects the cost of living of the rich... not an issue that affects middle class living standards.

Jared Bernstein argues that our knowledge of the size of the bias is shaky, and that it is a distraction from more important debates:

That Distracting Living Standards Debate: Jared Bernstein

Let us now discuss David Leonhardt’s article this AM in the NYT, specifically, the adjustment to the CPI that changes flat male median real earnings into a real growth rate of around 27% http://www.nytimes.com/2006/09/20/business/20leonhardt.html?ex=1316404800&en=8edad6d6ede72817&ei=5090&partner=rssuserland&emc=rss.

The argument in the paper focused on the “new goods” bias in the CPI: the problem of not incorporating new goods into the index until they’ve fallen a lot in price (thus missing the price decline). Dean Baker raises good questions.... I just wanted to raise a few other points....

3) There is a false degree of certainty to these bias adjustments.... Jack Triplett http://www.csls.ca/ipm/12/IPM-12-Triplett-e.pdf notes: "...what I liked least about the Commission Report was exactly what made it so influential — its guestimate of 1.1 percentage points of bias."...

That does not mean living standards have deteriorated. Living standards comprise many different aspects of life, from health advances to cheaper gadgetry.... But... this middle-class debate... I fear it’s a distraction.... [R]ight now, those of us who seek a different set of policy responses to the big challenges we face... would be better off talking much more about that agenda, and not arguing over whether the middle class is better off relative to 30 years ago.

That argument also sets an incredibly low bar. Real GDP... per-capita, [up] something like 90% [over the past three decades).... [T]he more important points are a) anyway you cut it, the middle-class was reaping much more of the benefits of the growing economy years ago than they are now, and b) as the structure of the economy and job market has changed, the distributional institutions—-unions, minimum wages, fiscal policy, full employment-—far less operative today.

Finally, as Leonhardt sort of suggests, it's a political distraction to have this debate about the 30-year record. The last six years are where all the political action is: we've had stellar productivity growth, but the real median household income of working age families is down 5%, $3,000 in 2005 dollars (2000-05). This is an incredible indictment of the current economic regime (and of YOYO economics--see http://www.noyoyoeconomic.com yet the elites are scratching their heads wondering why people don't get how great they're doing.

I am in broad agreement with Robert Gordon on the potential size of CPI bias, with Jared Bernstein on our lack of knowledge of how large it really is, and with Jared Bernstein again that a big CPI bias should not make us feel happy about the income distribution. And I tend to weigh in against Dean Baker on the size of CPI bias, against Bob Gordon (or at least against Mike Boskin) on how certain we are of our estimates, and with all three (i.e., all except Mike) that America would be a better place with more social democratic policies. Moreover, the bigger CPI bias, the more social democratic we should be.

Think about it. If there is 20% of CPI bias in the past 30 years, then median male real earnings have risen by 30% instead of the 10% in official statistics. But real national income per capita has risen by 125% rather than by 90%. A country that is so phenomenally more productive than the country of the mid-1970s should be able to do a much better job at providing an economic environment in which all Americans can have greatly improved income security, education for their children, and leisure time, as well as a much greater share in the rises in real material standards of living of which the rich have grabbed the lion's--no, much more than the lion's, the tyrannosaurus's--share.